Price Fluctuations in Relation to Economic Activities

Price Fluctuations in Relation to Economic Activities Prices are negatively correlated to economic activities Ferderer, 1996 . Most Ž . post-war recessions were preceded by oil price shocks, i.e. 1974, 1980 and 1990 economic recessions in the US Huntington, 1998 . Evidence that a recession Ž . depresses prices recently occurred in 1998, when oil prices declined to approximately $10 a barrel as a result of the Asian economic setback that started in 1997. Lower oil prices would prohibit economic development and might generate political instability and social unrest in some oil-producing countries. The rollercoaster of sharp oil-price fluctuations has been remarkable in the last three decades.

Thus, it is of great importance to analyze important factors affecting the volatility of crude oil prices. The literature on price volatility of crude oil relates oil shocks either to the instability of the market structures or to the effect of the price elasticity of demand. Mork 1989 and Huntington 1998 demonstrated the asymmetric rela- Ž. Ž. tionship, that a reduction in oil prices does not necessarily lead to noticeable output growth, while an increase can have a negative impact on output growth. The study of Ferderer 1996 points to the observation that disruptions in oil market Ž . not only give rise to higher prices, but also increase oil price volatility. Chaudhuri 2001 recently found that non-stationary commodity prices could be Ž . attributed to the nonstationarity in oil prices. In other words, real oil prices and real commodity prices are cointegrated. Thus, he suggested that the price of oil should be another variable in the aggregate production function. Given its volatility, it comes as no surprise that the majority of researchers considers the oil price as being non-stationary, i.e. it may well have a unit root e.g. Bentzen Ž and Engsted, 1993, 1996; Jones, 1993; Hamilton, 1994; Arize, 2000 , despite the . conclusion by Pindyck 1999 that long-term oil prices are mean-reverting around Ž . shifting trend lines. While advances in the non-stationary time series technique are instrumental in understanding the behavior of oil prices, the mechanism of the data-generating process plays a critical role. That is, the underlying structure of oil markets, especially OPEC, can shed important light on the issue.

In his pioneering work, Griffin 1985 characterized OPEC behavior into four Ž . categories: cartel, competitive, the target revenue, and property rights models. He